Enough With the Old Chinese Debt Already

posted by Mark Weidemaier

Mark Weidemaier and Mitu Gulati

We may be partly to blame for the fact that stories keep surfacing about whether the U.S. government might help holders of pre-revolutionary, defaulted Chinese debt monetize their claims. Here’s Tracy Alloway of Bloomberg, with a good assessment of the political and legal basis for this kind of intervention. The bonds have been in default since the 1930s. China won’t pay these pre-PRC debts. Taiwan sends its regrets. But a vocal contingent of American bondholders is lobbying for the U.S. government to intervene. The precise manner of intervention is not clearly defined, but the basic idea is that the bondholders could assign their rights to the U.S. government, which could then use the bonds to offset U.S. debts to China. As Alloway quotes the President of the American Bondholders Foundation (a bondholder group): “What’s wrong with paying China with their own paper?”

Look, we’re torn here. Expressed like that, the idea is bonkers. No, it’s worse. If you’ll forgive an obscure theater reference: compared to a bonkers idea, this idea is lying “in the gutter looking up in wide-eyed admiration.” Sure, the US government could try to “pay” China with defaulted Chinese bonds. It could also try to pay with toilet paper or chewing gum.* We have to assume this would be a credit event triggering CDS contracts issued on the U.S. And to be fair, from a certain armchair perspective, that would be…entertaining?

The entire idea has entertainment value, which may be one reason it has gotten so much attention. It also provokes some legal questions that have just enough depth to entertain lawyers. For instance, the statute of limitations is the most obvious barrier to bondholders getting money judgments against China. (Of course, an even larger barrier is the difficulty enforcing a judgment against the Chinese government.) Would it revive these stale claims to assign them to the U.S. government?

In the usual context, the answer would be “no.” The background here is that the law sometimes lets parties assert time-barred claims defensively. Assume that A and B each owe the other a debt, but A’s claim against B is time-barred. On that assumption, A can’t sue B to recover on the claim. If B sues A, however, A can use its claim to reduce the amount it owes to B. This is called the right of recoupment. But the right exists only when the two claims arise out of the same transaction. If they are unrelated, A is out of luck. One consequence of this rule is that a party holding a time-barred claim can’t “revive” the claim by assigning it to another party. For example, now assume that A holds a time-barred claim against B but owes no debt to B. Can A monetize the claim by assigning it to C, who owes B money and expects to be sued? Nope. The claim is valueless to C, because it is time-barred and doesn’t arise out of the same transaction as C’s debt to B. (There may be other reasons too, and the result is eminently sensible. A contrary rule would make it trivially easy to circumvent the statute of limitations.)

Except, if you sue the U.S. government, it can reduce its debt to you by asserting a time-barred “claim of the United States,” even if this claim does not arise out of the same transaction as yours. (This is 28 U.S.C. 2415.) Is a claim received by assignment a “claim of the United States?” We doubt it, but it’s not utterly implausible.

Still, the idea is crazy. Even if claims under these old bonds would suddenly be timely if assigned to the U.S., there is no practical way to use them to reduce the U.S. government’s payments on debt held by the PRC. And the attempt to do so would likely violate regulations governing the Treasury’s issuance and payment of bonds.

OK, you might say, but this whole idea of using the bonds to “pay” the Chinese government is just a metaphor. What the bondholders really want is for the U.S. government to intervene politically. Exactly! Of course the U.S. government can try to pressure the PRC to pay some kind of compensation. In the 1980s, for example, China agreed under pressure to make a small payment in recognition of bond debt held by British bondholders. But the U.S. government can expend political capital on behalf of any interest group (like holders of IP rights) and in support of any objective (maybe something related to trade? Just spitballing here.) There’s nothing special about holders of pre-revolutionary Chinese debt.

Actually, there is something special about these claimants: their rights have been stale for decades and derive from financial instruments that the S.E.C. recently called “collectible memorabilia with no meaningful investment value.” If we were to rank interest groups in terms of the extent to which they deserve support from the U.S. government, this one would be, well, lying in the gutter staring up at all the rest in wide-eyed admiration.

The idea that President Trump might spend some of whatever leverage he thinks he has gained in his trade war with China to advocate on behalf of this group of claimants is… plausible? But also kind of concerning? Surely there are bigger fish to fry. We also worry that some bondholders hope that media attention of this issue will drive up prices temporarily, letting them exit at a profit. Anyway, enough with the old Chinese debt already.

*We know, we know. This assumes, implausibly, that the US can identify which bonds are held by China, that it can selectively reduce the amount it pays on those bonds (or, what, tender old Chinese bonds in lieu of the normal payment mechanism?), and that the Chinese government doesn’t sell the bonds to someone else. But whatever. This is fantasy land.

Comments

Taiwan's position (as explained in the linked story) is interestingly hedged and complex. Taiwan's first argument is they don't control the railroads any more, that the bonds were issued to build. OK, but were the bonds actually linked to the railroad revenue or general obligations of the Chinese government?

Then, we have Taiwan's suggestion they might honor them after reunification. There is precedent for this "we'll pay you after we win" concept - most Confederate currency stated it was redeemable in specie some period of time after ratification of a peace treaty between the CSA and the USA. Does holding open even that remote possibility constitute some sort of ratification?

To be clear, I don't hold any of these bonds and I think the chances of their ever being enforceable are vanishingly slim. The Mega Millions lottery is a much better investment. I just find this to be an interesting intellectual exercise that raises thought provoking issues about the legal status of Taiwan.

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